Bumpy ride ahead for global economy?

London, December 30, 2013

This coming year, the global economy is in for a bumpy ride as the end of the unprecedented monetary stimulus will lead to higher interest rates, while the lower asset prices across the globe will inevitably feed into weaker global consumption and investment

Economists are famous for making wrong predictions. In December 2012, most economists predicted the end of the Euro, a hard landing of the Chinese economy and continued strong performance in emerging markets (EMs). Far from it, confidence in the Euro was restored this year, Chinese growth is accelerating again and most EMs are suffering one of the worst economic crises in decades.

So, how about next year? According to QNB Group, 2014 will mark the end of the unprecedented monetary stimulus central banks around the world have engaged in since the global recession of 2009. This, in turn, will imply higher global interest rates, a healthy downward adjustment in asset prices and a rotation away from vulnerable EMs in favor of selected advanced economies.

The road for the global economy is likely to be bumpy in the process, said the top Qatari lender in its report.

Looking back, 2013 was marked by three significant developments in the global economy. First, the euro area finally came out of a long recession and confidence in the single currency was restored. This has enabled Ireland to exit the bailout program it entered in 2010. Ireland and Spain (and to a lesser extent Greece, Italy and Portugal) are also seeing the first signs of economic recovery. This trend is likely to continue in 2014.

Second, much of the worries about a hard landing of the Chinese economy turned out to be unfounded. Since 2009, the Chinese economy has grown by an average 9.2 per cent a year and has contributed about half of the global output expansion.

A slowdown in the first half of 2013 turned out to be temporary and the Chinese economy is now accelerating again, driven by an expanding middle class and a shift from the traditional export-led model to a more domestic consumption-driven one. As a result, QNB Group expects 8 to 8.5 per cent Chinese growth next year.

Third, the announcement on May 18, 2013 of a potential scaling back of the Fed’s asset purchase program - the so-called tapering of Quantitative Easing (QE) - turned the winds against most EMs.

Global capital flew out, leaving EMs with large current-account deficits scrambling for cover. Brazil, India, Indonesia, South Africa and Turkey all experienced a substantial weakening of their currencies and a slowdown in economic activity.

Brazil, in particular, entered into a recession in the third quarter. Capital flight is likely to continue as QE tapering is implemented next year. As a result, EMs will be forced to reduce their own economic growth in order to bring their current account deficits back to a sustainable level by tightening both fiscal and monetary policy, stated the QNB report.

So, where is the global economy heading in 2014? The answer lies in the direction of monetary policy going forward. Central banks around the world have engaged in an unprecedented monetary stimulus to get the global economy out of the Great Recession of 2009. In doing so, they have flushed the global economy with unprecedented amounts of liquidity.

The Fed, for example, has increased its balance sheet fivefold to $4 trillion by purchasing US long-term government debt and mortgage-backed securities. This has reduced long-term interest rates (including mortgage rates) to historic lows, fueling house prices and equity indexes.

In the meantime, the US economy is still struggling to gather significant momentum to achieve its long-term growth potential, stated the QNB in its review.

On December 18, the Fed announced that it will reverse course starting in January 2014 by tapering QE. Inevitably, this will lead to higher long-term interest rates.

According to QNB Group, the US 10-year bond yield is likely to rise to 3.5 per cent in 2014. This will have a negative impact on the US housing market and construction activity. It will also reduce the wealth effect currently fueling higher US domestic consumption, stated the Qatari bank.

In the same vein, equity prices are likely to be affected by higher interest rates through higher discounting of future earnings and lower dividends from weaker growth. For 2014, this may imply a healthy downward adjustment in asset prices, bringing them to a more sustainable level in line with fundamentals, it stated.

According to QNB, the other central banks too are following the Fed’s example. The ECB issued nearly 530 billion euros in crisis loans to European banks in March last year, half of which have now been repaid.

The Bank of England has announced that it will no longer increase its QE program and will instead start increasing interest rates once unemployment falls below 7 per cent. The only exception is the Bank of Japan, which is sticking to its goal of doubling the money supply by outright purchases of government bonds, said the report.

QNB said overall, the change in direction of monetary policy signals the end of an era of unprecedented cheap money.

"As interest rates rise globally, a downward adjustment in asset prices is inevitable. At the same time, a rotation away from more risky EM investments to safer asset classes in advanced economies is likely," it stated.

"This change in direction is going to be bumpy for the global economy as higher interest rates and lower asset prices will inevitably feed into weaker global consumption and investment," the QNB added.-TradeArabia News Service